Saturday November 22, 2014

The Dirty Dozen: Shareholder Issues

An analysis of the coming proxy season reveals a dozen “dirty” issues directors should expect.

For film buffs, The Dirty Dozen—the 1967 classic with Lee Marvin, Charles Bronson and Jim Brown, not the various retreads—is an iconic movie. For pop culture devotees, the phrase conjures up countless year-end lists running down the dozen “worst” of this or that.

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For corporate directors, the following “dirty dozen” questions offer a rudimentary early warning system for the coming proxy season. While some of these questions touch on perennial concerns (such annual elections and majority voting), the primary focus is the new challenges, including a possible sophomore slump in vote support on say on pay, renewed calls for mandatory auditor rotation and a dog’s breakfast of proxy access resolutions. Whether the 2012 season gets really messy, however, largely hinges on two uncertainties: the direction of the market’s next mood swing and potential seepage from the looming U.S. presidential campaign.

1. Are your owners optimistic or pessimistic heading into season?
At the outset of 2012, most of the warning signs for board service becoming fodder for continued scrutiny were in place. Shareholder returns last year were largely flattened by the ongoing global economic crisis. Market volatility, fueled by investors’ anxiety, is off the charts. Dividend payouts remain low. Unemployment is sky-high, growth weak.

Meanwhile, the anti-elite Occupy Wall Street (OWS) movement and other corporate bashers paint corporate directors and executives as non-innocent bystanders who have been content to hoard cash, cut costs (read: jobs) and wring their hands over regulations while the economy burned. With all signs pointing to 2012 disclosures of big paydays for many CEOs and other top corporate managers despite 2011’s anemic returns, look for OWS and its cohorts to do their best to brew up an anti-board backlash.

Will this wealth of bad economic news and public animosity toward economic elites translate into a contentious meeting season? In years past, preseason opinion polls designed to measure shareholders’ mood swings proved highly predictive of a proxy season’s potency. An upbeat investor class entering 2011, for example, accurately forecasted a relatively mild annual meeting season.

This year, however, poll-land is shrouded in fog. In fact, the key survey data show a sharp divergence in attitudes between institutional owners, who appear to be optimistic, and individual investors, who are nearly as downbeat as they were at the depths of 2009’s market meltdown.

Institutional investors’ confidence enters the year with positive momentum. The State Street Investor Confidence Index, which measures confidence/risk appetite quantitatively by analyzing buy/sell patterns, steadily rose throughout second half of 2011. Global investor confidence (a reading of 100 is considered neutral) hovered at 99.3 in December, up from the August reading of 88.1.

Somewhat paradoxically, individual investors’ confidence appears to have been shattered by months of market gyrations. The Well Fargo/Gallup Investor and Retirement Index plunged to – 45 in September from 33 in May. This freefall put the Wells Fargo/ Gallup Index near its all-time record low (–64) set in February 2009, on the eve of the equity markets hitting rock bottom. (The index peaked at a whopping 178 in January 2000, just before the dot-com bubble burst.) How will this investor optimism gap play out in terms of proxy voting behavior and shareholder activism?

Mainstream money managers and other investment professionals may voice frustration over market volatility, but they generally view uncertainty as opportunity. Their more activist cousins—large public employee and labor union funds, some non–U.S. investment managers and hedge funds—view boardroom vulnerability as opportunity. Accordingly, these activists appear to be on track to boost their efforts to push reform measures during the coming proxy season.

For smaller investors, massive market fluctuations have bred uncertainty. Notably, two out of three investors (65 percent) told the Wells Fargo/Gallup Index pollsters that they feel “little or no control” in their efforts to build their retirement savings. As a result, look for some individual investors to take their frustrations out on board members during annual meeting season.

Prior to the season, directors need to take the temperature of their shareholder constituents. Did company performance lag the market? Is the company’s stock price way off its LTM highs? If the answers to these questions are yes, beware.

2. Is my board in the say-on-pay red zone?
The big question entering the sophomore say-on-pay campaign surrounds potential electoral escalation.

With the Dodd-Frank Act mandating advisory votes on compensation at most U.S. companies in 2011, shareholders were provided with an alternative avenue to express their views on corporate pay programs. Taking advantage of this pressure valve, investors largely ignored members of compensation committees and other directors when they had concerns over pay levels. Instead, proxy voters used the advisory pay votes to send warnings to board members. Many investors who voted “nay” on say on pay in 2011 may seek to expel board members at this year’s meetings if they feel that their concerns about compensation have been ignored.

Accordingly, directors must determine whether last year’s say-on-pay results put them in the red zone—where angry voters could score significant negative tallies against board members. ISS’s 2011–2012 Policy Survey indicates that investors’ views vary on where this imaginary line should be drawn. The biggest bloc (36 percent) of shareholder respondents said that they expect boardroom reassurances whenever overall say-on-pay opposition tops 20 percent. Another 24 percent of the investors raise the negative vote bar to 30 percent, but half that number (12 percent) actually lower the hurdle to opposition in excess of 10 percent. All told, nearly three-quarters (72 percent) of investor respondents indicated that an explicit response from the board regarding improvement on pay practices should be made at opposition levels of “more than 30 percent.”

Applying this 30 percent-or-higher opposition yardstick, a limited number of boards should be vulnerable to substantial “no” votes in 2012, thanks to directors’ engagement efforts last year. Average support for say-on-pay resolutions at Russell 3000 Index firms topped 90 percent in 2011. Three-quarters of these Russell 3000 issuers—including more than 300 S&P 500 firms—received support from more than 90 percent of the votes cast.

That leaves fewer than 200 Russell 3000 firms in the danger zone. Around 40 firms—more or less depending on how abstentions were counted—lost the votes outright. Another 150 Russell 3000 firms fell into the “near-miss” category. Notably, only eight large-cap S&P 500 firms drew less than majority support; fewer than 50 more landed in the more-than-30-percent-but-less-than-50-percent “no” vote bucket.

Of course, directors at another 500 firms could find themselves in the red zone, by default, as a result of their decisions to opt out of annual say-on-pay votes in favor of biennial or triennial frequency for future advisory votes. As of December, annual votes had garnered majority (or plurality) support at 80 percent of companies in the Russell 3000, but triennial votes drew the greatest support, at 19 percent of issuers.

The Securities and Exchange Commission requires issuers to respond to the votes regardless of the outcomes. New regulations require all issuers to address, in the Compensation Discussion & Analysis section of the proxy statement, whether and how their compensation policies and decisions have taken into account the results of the most recent say-on-pay vote.

Boards at firms with failed say-on-pay votes face an uphill battle in 2012 unless they are willing to make major changes to their pay practices. Do not expect to see pay overhauls at all 200-plus red-zone firms, since investors’ views vary on the actions required to constitute an explicit response on say on pay.

At a minimum, most shareholders expect disclosures in plain English, set out in an executive summary rather than buried in the CD&A, that allow them to determine whether the company has taken actions to address the compensation issues that contributed to the low level of support.

As a first step, boards should outline their outreach efforts. Many firms at the upper extremes of the say-on-pay red zone have used the preseason lull to reach out to their biggest investors. Where these investor engagements led to changes, the boards have detailed the specific actions that they have taken to address the concerns.

One cautionary note: Boards with support above the 70 percent red-zone line should avoid declaring victory. Suffice it to say, many investors really do not care about the cumulative negative vote. As one large mutual fund manager bluntly put it during an ISS client roundtable: “If I voted ‘no’ on say on pay, I expect a response.”

3. Is pay linked to performance?
During the first year of the say-on-pay mandate, pay for performance proved pivotal to proxy voting decisions by institutional investors. Simply put, shareholders’ pocketbooks ruled when it came time to vote on say-on-pay resolutions.

Results from 2011 meetings show that pay-for-performance disconnects were a high-speed train ticket to subpar support. Two-thirds of the failed say-on-pay votes were rooted in pay/performance disconnects. In fact, almost half of those failed-vote firms reported double-digit negative three-year total shareholder returns. Such misalignment also drove more than half of the remaining sub-70 percent support tallies.

Given the importance of pay for performance, a 2011 survey that showed CEOs’ pay packages and investors’ returns possibly moving in opposite directions should sound boardroom alarms. An executive pay flash survey of 265 midsize and large North American firms, conducted in late October and released in early December by the consultant firm Towers Watson, found that most companies expect to pay bigger bonuses to C-suite executives despite anemic investor returns.

The Towers Watson survey also found that 61 percent of the respondent firms expected total shareholder returns for 2011 to decline or remain flat. Despite this bleak outlook, the same percentage of firms expected their annual bonus pools for 2011 to be “as large or larger” than those for 2010. An outright majority of the firms polled by Towers Watson said they planned to pay 2011 bonuses that are larger than or equal to 2010’s payouts. Notably, just 13 percent of the respondents— down from 35 percent three years ago, at the depths of the market collapse—anticipated that compensation panels would override incentive plan formulas.

In perhaps the understatement of the year, Towers Watson noted, “The prospect of above-target incentive awards combined with shareholder losses could pose complications and communication challenges as they head into the 2012 proxy season.”

In drafting proxy statement disclosures about pay for performance, boards need to view the issue through shareholders’ eyes. Institutional investor respondents to ISS’s 2011–2012 Policy Survey indicated that evaluating pay-for-performance alignment requires more than a simple demonstration of directional alignment between realized pay and a performance metric. A whopping 88 percent of the investor respondents, for example, said they believe pay increases that are “disproportionate” to the company’s performance trend are “very” relevant; another 11 percent considered it “somewhat” relevant. Pay relative to peers is considered “very” relevant by 62 percent of the investors and “somewhat” relevant by 32 percent.

The lowest rates of support on say on pay were garnered at companies that exhibited pay-for-performance disconnects in tandem with problematic pay practices. At the top of investors’ pay pet peeves were tax gross-ups, discretionary bonuses and inappropriate peer benchmarking. Notably, many companies announced new pay reforms in their 2011 proxy statements.

Such problematic pay practices will continue to attract shareholder proposals in 2012. The AFL-CIO, for example, is submitting proposals asking boards to limit accelerated vesting, adopt tough share-retention requirements, eliminate tax gross-ups, close down golden coffins and restrict severance packages.

The Laborers International Union of North America’s (LIUNA’s) pension fund and the Amalgamated Bank’s LongView Fund offer proposals asking companies to limit executives’ accelerated vesting and to link executive compensation to various sustainability measurements.

In addition, some firms will be asked to beef up clawback provisions. The New York City Pension Funds has filed shareowner proposals at some of the big financial firms, including JPMorgan, Goldman Sachs and Morgan Stanley, asking for sharper clawback policies.

Directors’ fears that say on pay would usher in an era of governance by referendum should draw some solace from shareholders’ thumbs-down vote on proposals looking to require advisory votes on boardroom pay. During the 2011 proxy season, five say-on-director-pay resolutions went to a vote and averaged just 17 percent support.

Despite this uneven support, some retail activists continue to push for board pay referenda. Activist investor and blogger Jim McRitchie, for example, wants Apple to provide an annual nonbinding vote on outside director compensation.

4. What drives high “no” votes on directors?
By and large, last year’s proxy season was a cakewalk for most directors who stood for election. The advent of say on pay, a dearth of “just vote no” campaigns and a positive shareholder outlook entering 2011 produced landslide votes in favor of board nominees.

The overwhelming majority of directors at U.S. companies were elected at 2011 meetings with more than 90 percent shareholder support. Average support for nominees grew to an eye-popping 96 percent at S&P 500 firms.

The number of directors at Russell 3000 firms that failed to garner majority support fell by nearly half. Around 50 directors at Russell 3000 firms failed to win a majority of votes for their election. During the same periods in 2010 and 2009, 91 and 93 directors, respectively, failed to garner majority support.

Unlike 2010, when concerns related to executive compensation were a factor in nearly one-third of failed director elections, pay-related concerns were a factor in only a handful of negative tallies in 2011. Instead, a trio of perennial concerns—poor attendance, unilateral board adoption of a poison pill and the failure to implement majority-supported shareholder proposals—were the biggest drivers of majority dissent against board members. Shareholders also registered discontent against boards that did not address underlying reasons behind failed director elections at the prior year’s meeting.

As in past proxy seasons, most of 2011’s majority-opposed board nominees serve at smaller companies that have plurality vote standards without resignation requirements for candidates who fail to attract majority support. While such resignation policies were triggered a handful of companies last year, most were rebuffed by boards.

Such board inaction following large negative tallies for nominees will spur efforts to move U.S. companies to majority voting rules. Over the past decade, private ordering on majority voting has become a juggernaut. Nearly 80 percent of large-cap S&P 500 companies now have full-blown majority-voting rules and/or plurality-plus director resignation requirements in place.

The absence of large-cap targets has pushed activists to look downstream. In 2011, shareholder proposal proponents targeted middle-market and small-cap firms. In fact, only eight of the 34 Russell 3000 firms that received majority tallies in favor of majority voting shareholder proposals in 2011 were part of the large-cap S&P 500 Index.

Strong support is spurring boards at these smaller firms to act. Twenty Russell 3000 firms asked shareholders to approve bylaw or charter changes locking majority-voting rules in place; only eight of them were large-cap firms.

The United Brotherhood of Carpenters and Joiners of America pension fund, which offered the alpha majority-voting proposal back in 2003, will continue to lead the cleanup effort in 2012. The fund plans to offer around 25 nonbinding proposals asking boards to put teeth into their director election rules. If recent campaigns are any indication, a significant percentage of these proposals may be withdrawn.

The two behemoth retirement systems— the California State Teachers Retirement System (CalSTRS) and the California Public Employees Retirement System (CalPERS)—also plan to pick up where they left off last year with their campaigns to spread majority voting beyond the S&P 500.

CalSTRS recently sent letters to about 100 companies in the Russell 2000 Index. So far, at least two dozen of these boards have agreed to adopt some form of majority voting in director elections. To continue the effort, CalSTRS has filed majority-vote proposals at 50 companies.

Over the past two years, CalPERS lobbied 39 companies in the Russell 1000 to adopt majority voting. To date, about three dozen have adopted the practice. For the 2012 proxy season, CalPERS has submitted 13 proposals asking companies to adopt majority voting.

Shareholders’ assault on staggered board turns also accelerated in 2011. Around 50 Russell 3000 issuers nixed their classified board structures; nearly half of them (24) are large-cap S&P 500 firms. Look for these efforts to grow in 2012.

A steady flow of proposals is expected that look to eliminate super-majority vote requirements and to boost shareholders’ rights to call special meetings or to act via written consent.

5. How many proxy access shareholder proposals for 2012?
Boards at some high-profile companies may learn—the hard way—that private ordering is messy business.

The SEC’s mandatory proxy access rule (Rule 14a-11), which would have required investor groups to hold a 3 percent stake for at least three years and imposed a 25 percent cap on the board seats that could be contested, was vacated by the D.C. Circuit Court in July. While corporate pressure groups convinced the federal appeals court to block the universal access rule, the legal challenge did not disturb related changes to the Commission’s shareholder proposal rules that undercut issuers’ efforts to exclude from their proxy materials shareholder proposals addressing board nominating procedures.

When the Commission lifted the stay on its amendment to Rule 14a-8 in September in conjunction with its decision not to appeal the court decision, the gates opened for proxy access shareholder proposals. Investors did not rush into action. Early on, it appeared as though few, if any, resolutions would be filed, as some activist investors openly questioned whether a robust round of private ordering would help or hinder efforts to convince the SEC to reignite its push for a uniform federal mandate.

Once it became clear that the SEC was unlikely to fast-track the reintroduction of its rule, a steady stream of proposals began to flow. As of late December, investors had filed nearly 20 proxy access proposals for the 2012 proxy season.

What the proposals lack in numbers, they more than make up for in variety. Some proposals are precatory; others take binding bylaw form. Some proponents mimic the SEC’s “hard six” thresholds (a 3 percent stake held for three years); others set hair-triggers.

Interestingly, 2011 say-on-pay results appear to have influenced the selection of proxy access targets as proponents take aim at a pair of boards—Hewlett-Packard and Nabors Industries—that suffered high-profile losses on pay advisory votes last year.

The labor-oriented Amalgamated LongView Fund is targeting HP with a nonbinding proposal asking the troubled tech giant’s board to adopt a bylaw that mimics the SEC’s now-vacated access rule.

Meanwhile, a gang of activist public employee funds—from California, Connecticut, Illinois, North Carolina and New York City—filed a similar access proposal at Nabors, a Bermuda-based oil-drilling contractor. “Nabors has a long history of poor governance, including a board that has consistently been unresponsive to shareholder concerns,” Janet Cowell, state treasurer of North Carolina, one of the proponents (that collectively own about 1.7 million of Nabors’ 288 million shares) said in a Dec. 13 press release.

In an unanticipated move, Norges Bank Investment Management, which manages Norway’s $550 billion pension fund, raised the stakes by filing binding proxy access proposals at a half-dozen companies, including Wells Fargo, Charles Schwab and Staples. At the time of the filings, NBIM held stakes of 0.6 percent to 1.1 percent in these companies, valued at a total $1.4 billion.

The NBIM proposals seek more permissive access standards than contained in the SEC’s invalidated universal access rule, and set the minimum access threshold at a 1 percent stake held for at least one year, with a 25 percent cap on the percentage of board seats available for access candidates. “Board members must be held accountable,” said Anne Kvam, global head of ownership policy at NBIM. “When they fail to meet our expectations, we as shareholders should be able to propose alternatives without incurring prohibitively high costs.”

While many institutional activists express support for Rule 14a-11’s thresholds, retail activists have argued that those hurdles are too high and would bar small shareowners from nominating board candidates. So the United States Proxy Exchange (USPX), a nonprofit organization funded by individual investors who pay membership dues, drafted a small-shareholder-friendly model proxy access proposal as an alternative to the SEC’s access rule.

The USPX model urges boards to adopt an access bylaw that would permit director nominees from: (1) any party of one or more shareowners that has held continuously, for two years, 1 percent of the company’s securities eligible to vote for the election of directors; or (2) any party of shareowners of whom 100 or more satisfy SEC Rule 14a-8(b) eligibility requirements (i.e., those who hold at least a $2,000 stake for one year). Any such party may make one nomination or, if greater, a number of nominations equal to 12 percent of the current number of board members, rounding down.

Longtime retail activist Kenneth Steiner jumped on the USPX low-threshold bandwagon by filing nonbinding resolutions at nearly a half-dozen companies, including big names Bank of America and Sprint Nextel.

Shareholder activist McRitchie (Goldman Sachs) and giga-gadfly John Chevedden (Chiquita Brands International) also submitted USPX-style low-threshold access proposals.

Handicapping untested proposals is never easy, but the Rule 14a-11 clones at HP and Nabors have the potential for nose-bleed-high support. HP typically holds its annual meeting in March, so the company likely will be the first test for access. A similar resolution submitted to HP by the American Federation of State, County and Municipal Employees (AFSCME) back in 2007 received support from 43 percent of the votes cast.

Support for the USPX proposals is much less certain. The Council of Institutional Investors, which represents public, labor and corporate pension funds, released a statement on proxy access. While the statement did not specifically mention the USPX-inspired resolutions, it did encourage CII members and other long-term shareowners to use the new tool in “a focused and consistent manner.” Specifically, CII noted its concern that access rules should require nominators to have beneficially owned “a meaningful percentage of the company’s voting stock continuously for a meaningful period of time.”

6. Who is the chair?
If any boardroom job warrants a “toughest job” label, it is probably lead director. Generally underappreciated, usually underpaid and often overworked, lead directors have become the Rodney Dangerfields of the boardroom universe. In other words, they get no respect.

The NACD attempted to add some substance and luster to the position via a recent Blue Ribbon Commission report, but activists (and some board members) do not appear to be prepared to give the position any street cred.

As a result, a bumper crop of proposals asking boards to tap independent directors as board chairs is expected for 2012 annual meetings. The Laborers union and the AFL-CIO, for example, are submitting proposals asking companies to separate the roles of chair and CEO. AFSCME has filed a proposal asking Goldman Sachs to take this step as well.

Independent chair boosters hope to build on 2011’s resurgence in voting support for the proposals, which included majority votes at four firms. The resolutions averaged 32.8 percent support at 23 Russell 3000 firms, a jump from 2010’s anemic 28.1 percent showing, and just below the previous high-water mark— 36.4 percent—back in 2009.

Some proponents will raise the stakes by offering binding bylaw amendments. London-based Hermes Equity Ownership Services and the Laborers union will team up to push a binding proposal to split the positions of chair and CEO at Moody’s. In 2011, a nonbinding proposal at Moody’s—co-filed by Hermes and LIUNA—received 56.6 percent of the votes cast, a significant boost from the 33.4 and 30.8 percent votes for independent chair proposals in 2010 and 2009, respectively. The company did not implement the proposal despite the strong showing. “We consider the board’s failure to implement last year’s proposal as a clear example of why greater independence is needed and that the alternative of a lead outside director, even one with a robust set of duties, is not adequate to fulfill these functions,” the proponents argued in their supporting statement.

The independent chair cause should benefit from a change in CII’s approach to unresponsive boards. In December, CII sent angry missives to eight boards whose directors, it said, have “ignored” majority-vote-winning shareowner proposals that synch-up with Council policies for two or more consecutive years where the board lacks an independent chair and/ or true majority-vote standard for uncontested director elections. The letters ask each board to name independent chairs and/or adopt majority voting. The goal, CII notes, is to ensure that an independent board member leads a review of the winning shareowner proposals, and that owners have a way to provide feedback to the board and hold directors accountable for their actions.

7. Should leadership be tied to succession planning?
The 2012 season could produce a wave of interest in CEO succession. The issue received significant attention just prior to the 2011 proxy season in the wake of the sudden ouster of HP’s chief executive and Apple founder Steve Jobs’ health problems. The Laborers union planned to file almost a dozen proposals last year but withdrew most of them or reached settlements before filing. Just two resolutions went to a vote in 2011, receiving 30.1 percent support at Apple and 23.9 percent at Kohl’s.

LIUNA and the AFL-CIO will file proposals this year asking companies to report on their CEO succession plans.

Succession issues will also arise in the context of director elections thanks to a decision by the Walt Disney board to recombine its CEO and chair titles as part of a slow-motion leadership change.

Looking five years into the future, the Disney board in October announced plans to award longtime CEO Bob Iger the chairman title along with a new long-term contract that would keep him at the helm through 2016. As part of the deal, Iger will recombine the roles in March when current chair John Pepper retires at the company’s annual meeting. By 2015, Iger will transition to executive chair for a 15-month period ending June 30, 2016.

The abrupt move spurred Connecticut State Treasurer Denise Nappier to send a letter to Pepper expressing disappointment in the board’s decision. In 2004, the Connecticut Retirement Plans and Trust Funds filed a shareowner proposal asking Disney’s board to change its governance guidelines to ensure that an independent member of the board serve as chair. After direct discussions between the treasurer’s office and then-board chair George Mitchell, the board adopted new guidelines, but provided the board with some wiggle room.

In her letter to Pepper, Nappier called the rationale for the decision to name Iger chair “extremely weak.” She pointed out that to assist in the transition to a new CEO, Iger does not have to be serving as chair. “The reasons to keep one person from holding these two positions are as sound today as they were in January 2005 when the governance change was adopted by the board,” the letter stated. Nappier also refuted the argument that a lead independent director is an adequate substitute for an independent board chair.

8. Should we switch audit firms?
The audit committee has been outside the spotlight in recent proxy seasons as attention focused on members of compensation and nominating panels. Audit committee members may reclaim their “toughest job” status in 2012 thanks to a very unlikely radical—Jim Doty, chairman of the Public Company Accounting Oversight Board (PCAOB).

In the early 1990s, Doty served as general counsel of the SEC. Prior to and following his SEC stint, he was a partner at Baker Botts in Houston. So when Doty was appointed by the SEC to head the PCAOB in January 2011, few eyebrows were raised. But Doty—who actually made his own appointment possible by leading the successful defense against a landmark challenge to the PCAOB’s constitutionality before the U.S. Supreme Court in Free Enterprise Fund v. PCAOB—quickly displayed a reformist’s zeal.

The accounting industry winced as Doty pushed an aggressive reform agenda. In August, the PCAOB voted to issue a concept release to solicit public comment on ways that auditor independence, objectivity and professional skepticism could be enhanced, including through the mandatory rotation of audit firms. Comments were due Dec. 14.

Mandatory audit firm rotation would limit the number of consecutive years that a registered public accounting firm could serve as the auditor of a public company.

The concept release notes that proponents of rotation believe that setting a term limit on the audit relationship could free the auditor from the effects of client pressure and offer an opportunity for a fresh look at the company’s financial reporting. “The reason to consider auditor term limits is that they may reduce the pressure auditors face to develop and protect long-term client relationships to the detriment of investors and our capital markets,” Chairman Doty explained. The concept release acknowledges that rotation opponents express concerns about the costs of changing auditors and believe that audit quality suffers in the early years of an engagement. The PCAOB asked commenters to respond to specific questions, including whether the board should consider a rotation requirement only for audit tenures of more than 10 years or only for the largest issuer audits.

Ed Durkin, director of corporate affairs for the Carpenters union, hopes to showcase the issue via an auditor rotation shareholder proposal. Durkin and his allies at the Sheet Metal Workers’ pension fund have filed more than 40 proposals asking the company’s boards to establish a policy to require the rotation of audit firms every seven years, with a three-year cooling-off period before an auditor could be retained again.

Initial signs indicate that the auditor independence area is ripe for engagement. Nearly half of the proposals were withdrawn after companies agreed to engage with the proponents on the full range of auditor independence concerns. A handful of companies, including HP and Disney, sought and were granted permission by the staff of the SEC’s Corporation Finance Division to exclude the proposals on the grounds that they relate to the companies’ “ordinary business” operations and thus are not appropriate matters for shareholder votes. At least five other companies have filed similar exclusion requests.

The Carpenters union fired off a letter to the SEC’s Division of Corporation Finance requesting a full review of the staff’s no-action-letter decisions that allow the three firms to exclude the proposal. In the Carpenters’ request for review, the fund argued that auditor rotation should no longer be considered “ordinary business” because it has risen to the level of a significant policy issue. The request cited the PCAOB’s concept release and the European Commission’s proposed legislation for the European Union countries that included a proposed mandatory auditor firm rotation every six years.

In December, Durkin’s appeal was denied and the SEC reaffirmed its position that auditor rotation proposals may be omitted as “ordinary business” matters. Under SEC rules, a proponent can seek reconsideration on requests that raise “matters of substantial importance and where the issues are novel or highly complex.” Applying this standard in a letter regarding the Carpenters union proposal at Deere, Thomas Kim, chief counsel for the Corporation Finance Division, wrote that the staff “determined not to present (Durkin’s) request to the Commission.” Given the SEC’s refusal to reconsider its initial rulings on this topic, it appears likely that the staff will grant all of its pending no-action petitions on the topic.

Despite this setback, the issue is unlikely to go away. Reversals are rare, but the SEC has changed its mind on ordinary business matters in the past. Even without such a reprieve, the “how long is too long?” question is not going away, given that more than one-third of S&P 500 firms have employed the same auditor for a quarter century or longer. Audit firm rotation has been discussed numerous times since the 1970s—most recently in connection with the passage of Sarbanes-Oxley in 2002. The PCAOB is set to convene a public roundtable on auditor independence and mandatory audit firm rotation in March.

9. Where can you be sued?
Another new proxy season issue deals with the forum for shareholder lawsuits. A self-serving March 2010 Delaware Court of Chancery opinion encouraged Delaware corporations to establish the Chancery Court as the exclusive venue for “intra-entity” disputes—claims asserting director and officer breaches of fiduciary duty, claims seeking to overturn directors’ business judgments on mergers, and other matters.

By July, around 80 Delaware corporations had adopted—typically without seeking shareholders approval—exclusive forum provisions. After the U.S. District Court for Northern California declared Oracle’s “exclusive forum” provision unenforceable in part because it was never submitted for shareowner approval, companies began to put the provisions up for votes. In 2011, companies had a tough time rounding up the support required for passage.

In an effort to eliminate existing exclusive- forum provisions, Amalgamated Banks’ LongView Fund is submitting proposals at several companies including Chevron and Roper. The proposals ask boards to repeal their exclusive-forum bylaws that were adopted by directors without shareowner votes.

Investors’ awareness of and opinions on exclusive-venue provisions are still emerging, but some large investors remain wary. Late last year CII’s general members approved a new policy discouraging companies from adopting charter or bylaw amendments that restrict the venue for shareowner litigation to a given forum. The Council believes that establishing one court as the sole venue for shareowners’ claims could potentially limit shareowners’ ability to bring meritorious claims.

10. Does the board oversee political spending?
When the U.S. Supreme Court ruled in 2010 that corporate political spending is protected as free speech, the decision ignited a firestorm of controversy that has simultaneously engulfed and fueled a once-sleepy shareholder proposal campaign aimed at boosting voluntary disclosure of corporate political spending.

The Citizens United case has turned corporate political spending into a white-hot topic. In the year following the Court’s controversial decision, the number of shareholder proposals addressing political contributions soared from 56 to 88, with 55 ultimately coming to votes in 2011.

The eight-year-old political spending reporting campaign, coordinated by the Center for Political Accountability (CPA), continues to account for the bulk of the activity. Support for the 35 CPA-style resolutions that came to votes at meetings reached 32.8 percent in 2011, up from 28.4 percent in 2010.

The success of CPA’s efforts has emboldened some activists to target other forms of corporate participation in the political process. AFSCME, for example, filed a proposal that requested a report on “grassroots lobbying” and corporate funds given to trade associations and other third parties that are used for political purposes. Another proposal, from NorthStar Asset Management, sought an annual shareholder vote to ratify political expenditures anticipated in the next fiscal year.

The debate should intensify in 2012, since most pundits predict record levels of political spending during a campaign cycle that will include the no-holds-barred fight between President Barack Obama and the eventual Republican nominee.

In addition, AFSCME reports that a broad coalition of more than 40 investors will be filing proposals asking for lobbying disclosure at more than 30 companies.

NorthStar Asset Management has released a position paper in support of its efforts to prod companies to hold shareholder votes on political spending. The firm plans to file a least a half-dozen proposals for the 2012 proxy season that seek such shareholder votes.

Investors’ appetite for political spending information appears to be growing. A majority of investor respondents to ISS’s 2011–2012 Policy Survey consider both the various types of corporate political spending—including direct contributions, contributions to trade associations or payments made for grassroots lobbying— and political spending-related disclosures, policies and boardroom oversight as either “critical” or “important.”

A Nov. 10 report by the Sustainable Investments Institute (Si2) found that political spending disclosure is on the rise. According to Si2, boards at 31 percent of S&P 500 companies now explicitly oversee such spending, compared to just 23 percent in 2010.

Interestingly, increased oversight and transparency did not mean less spending. Si2 found that companies with board oversight of political expenditures spent about 30 percent more in 2010 than firms without such explicit policies.

Si2 also calculated the direct political spending footprint for S&P 500 companies— the amount of money companies contributed to national political committees and state-level candidates, parties and ballot initiatives, as well as federal lobbying— at a massive $1.1 billion in 2010.

11. Have environmental and social issues come of age?
Investor support for shareholder resolutions on environmental and social (E&S) issues continues to rise. The last annual meeting votes of 2011 confirmed projections that average support for shareholder resolutions raising E&S concerns would top the 20 percent threshold in the U.S. for the first time.

The final average landed at 20.2 percent, up from 18.1 percent approval in 2010 and 16.3 percent the year before, both of which set high-water marks at the time. In sharp contrast, the average support for E&S proposals was just 8.7 percent a decade ago.

The vote average in 2011 included five investor proposals that received majority support (based on “for” and “against” votes), a record for E&S issues.

The season’s most eye-catching results— a 10 percentage-point rise in overall support—involved the second year of a campaign coordinated by the Investors Environmental Health Network that asked issuers to report on the implications of their use of hydraulic fracturing, also known as fracking, to tap natural gas reserves. Fracking is a natural gas extraction technique that involves the high-pressure injection of water, sand and chemicals into a gas-bearing shale rock formation.

Fracking proposals went to a vote at five companies and averaged 40.7 percent support. Given this success and the high profile of fracking in the media, this campaign is expected to grow in 2012.

Another new proposal for the 2011 season focused on workplace safety in the extractive sector. In the wake of recent fatal accidents at oil refineries (Tesoro’s Anacortes facility in April 2010 and BP’s Texas City refinery in March 2005) and the 2010 BP Deepwater Horizon incident in the Gulf of Mexico, shareholders sought greater transparency and accountability regarding workplace safety by filing resolutions at seven corporations, four of which came to a vote at 2011 annual meetings. A new AFLCIO campaign that asked oil companies to report on their actions to reduce the risk of workplace accidents received strong levels of support. At Tesoro, where a recent refinery accident resulted in fatalities, and Valero, where disclosure was limited, the proposals received 54.3 and 43.3 percent approval, respectively.

12. How will the upcoming elections impact proxy season?
Finally, it is impossible to talk about the upcoming proxy season without mentioning the 2012 presidential campaign.

Like major flu outbreaks and locust swarms, presidential campaigns are periodic events that can wreak substantial havoc. Since the early 1990s, when then- Governor Bill Clinton bashed CEO pay during his successful run for the White House, rhetoric from the presidential campaign trail has consistently managed to infect the contemporaneous proxy season. Most recently, then-Senator Obama rode a platform that included planks promising say on pay and other governance reforms to victory.

The campaigns shaping up for 2012 look to be no exception. While jobs and the economy are the linchpin issues for the presidential election, many of the campaign subplots resemble perennial proxy voting concerns.

The stakes on the outcome of the presidential election are huge. All of the major Republican challengers to President Obama call for the outright repeal of Dodd-Frank; some vow to kill Sarbanes-Oxley as well. The shift of a single vote at the SEC following a Republican capture of the White House would likely end efforts to revive the SEC’s now-vacated proxy access rule, and could imperil the remaining Dodd-Frank punch-list items (tougher clawbacks and hedging disclosures) that remain on the Commission’s plate.

Even say on pay may be at risk. While an outright reversal of the federal say-on-pay mandate might prove to be political kryptonite, a permanent exemption for small-cap firms is well within the realm of possibility. Under the SEC’s current rules, companies with market capitalizations below $75 million are exempted from the say-on-pay process until 2013.

Interestingly, the 2012 proxy season may bleed over to the political landscape. Investors’ pessimism appears to be driven, in large measure, by political inaction and the dysfunctional climate in Washington, D.C.

Large segments of individual investors polled for the Wells Fargo/Gallup Index fingered negative macroeconomic news—high unemployment (83 percent of the respondents), the federal budget deficit (79 percent) and the job growth rate (75 percent)—as the major factors that hurt the investment climate “a lot.” But seven out of 10 individual investors also called out both “a politically divided federal government” (74 percent) and “Congress’ debate over the amount of U.S. debt” (70 percent) for hurting the investment climate “a lot.”

One wild card for the upcoming season is the impact of the Occupy Wall Street movement and its various offshoots. While the Occupy movement moved indoors for the cold weather months, its hibernation could end with the annual meeting season this spring.

OWS spin-offs such as “Occupy the Boardroom” have already targeted individual directors at financial firms with hate mail. High-profile, made-for-mediacoverage annual meetings near major metropolitan areas where OWS protestors congregate provide tailor-made targets. Repeated high-profile clashes at early annual meetings could set a downbeat tone and turn a volatile season into a highly contentious one.

Finding the Right Answer
In the film, the fictional dirty dozen are asked to take great risks to accomplish a seemingly impossible task. All of the “experts” expect the dirty dozen to fail; some of these pundits put hurdles in their way. In the end, however, they accomplish their mission (albeit at a heavy cost) thanks to teamwork, strong leadership and good old-fashioned grit.

Corporate directors also face long odds and numerous naysayers as they seek to govern public companies through this period of economic and political uncertainty. Few, if any, of the dozen dirty little questions posed here offer simple answers. To find the “right” answers for each company, directors must work with management teams and engage with shareholders, regulators and other key corporate constituents.

Some alarmist advisors to boards have borrowed a page from the tin-foil-hat-wearing set (think Mayan calendar-predicted catastrophes) by suggesting that 2012 will mark the end of the governance world as we know it. While the 2012 season will offer some special challenges, it will not prove cataclysmic for boards.

Patrick S. McGurn is special counsel with Institutional Shareholder Services, an MSCI brand. ISS Governance Counsel Ted Allen contributed to this article.

Comments on “The Dirty Dozen: Shareholder Issues”

  • Wendy F. DiCicco says:

    Great prep for the proxy season and ISS interactions!

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